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Using debt wisely: a skill or a behavioral issue?

Introduction
To help Canadians manage their money better, the federal government established a Task Force in June 2009, and mandated it to make recommendations to the Minister of Finance on a national strategy to improve financial literacy of Canadians. This task force released its report in December 2010 with thirty recommendations, including one to conduct periodically a national Survey of Financial Capability of Canadians. The first such survey was conducted by Statistics Canada between February and March 2009, and a short report containing these data was released in December 2010.

Is financial literacy program of any help?
To promote financial literacy is a topical concern – especially in the current environment when most Canadians are steadily increasing their indebtedness due to stagnant incomes, changing labour market providing more precarious than well-paying jobs, creating a gulf between the earnings of those with and without the marketable skills. Then, on the demographic side, we are witnessing more family dis-solutions resulting in more women-headed single parent families, most with jobs with low-to-medium hourly wage rates in the services sector, likely vulnerable to rely on consumer credit. Yet another demographic group likely to use credit constitutes the rising number of the elderly living on fixed incomes including work-related and/or private pensions, and benefits from Canada Pension Plan, Old Age Security, and Guaranteed Income Supplement.

Besides these labour market and demographic forces pushing individuals and families to use consumer credit, low interest rates and sky-rocketing prices of homes, making buyers to take mortgages beyond their financial means, are also likely pushing current and new or potential homeowners to rely more and more on consumer credit, including charge cards, unsecured lines of credit, and other secured and unsecured loans for their day-to-day spending needs. Unfortunately, as the rising prices of homes are making home ownership beyond the reach of many, it’s creating, on the other hand, a bonanza for all those renting properties. These landlords are free to raise rents year after year, making tenants to spend more and more on rent, and use charge cards and other loans to meet their day-to-day living expenses.

Then there are individuals, mostly with low education, unskilled, and holding short-term or temporary jobs, who in turn, can’t secure credit cards and/or loans issued by banks and/or other financial institutions. They have either been denied access to credit cards because of their low incomes, or have exhausted their permissible spending limits on their existing cards. A good number of these individuals turn to private lenders like Payday Loans, Money Marts, or Cash-on-the spot, and become their prey for life. Such lenders or money sharks thrive on such poorly educated needy low earners who are prepared to meet their daily needs with funds borrowed at exorbitant rates. My heart goes to such people. For them, paying one loan with another becomes a part of their life.

Even though the Canadian federal government in cooperation with several provincial governments have been introducing some measures to protect such borrowers paying sky-rocketing interest rates, the measures in place are largely focused on controlling interest rates, but not the borrowers’ behaviour, or options to use funds from other sources. Since Canada respects an individual’s freedom, values, and right to choose his/her lifestyle, an individual is free to borrow money from any source he/she so chooses.

Individuals and families living with no or little cash flow are presumably living in financially straitened circumstances. Granted, some may have voluntarily abused credit by spending frivolously on acquiring luxury goods, misused student loans, taking expensive holidays, maintaining a lifestyle they could hardly afford, stretched themselves beyond their means, but the majority use credit to meet their current essential and nonessential expenses. The question I ask here is if any financial literacy program can help such users of credit, instruct them to manage their money better, save more for the rainy day, or for children’s post-secondary education, and above all, save for personal retirement.

In my view, no financial literacy program is going to help such individuals if their day-to-day living is at stake and they simply need immediate access to cash – even if it means going deeper into indebtedness. For such individuals, the survival is at issue. For them, offering them any course guiding them to handle money properly is like a drop of water on an oily surface. The mere lecture about managing money is not going to help meet their financial needs, or their day-to-day challenges of survival.

On the other hand, the well-educated, holding skilled jobs with good wages and salaries wouldn’t really require such literacy program – partly because most of these have likely picked up some financial knowledge while pursuing higher education. They may not all be professional wizards, financial or money smarts, but such people can at least consider the pros and cons about choosing a lender, or comprehend the kind of loan agreement they are signing. According to the 2009 Survey of Financial Capability of Canadians, highly educated, high income, and financially knowledgeable individuals had much higher rate and amount of indebtedness than their low educated, low income, and not so financially literate, counterparts.

These better educated individuals, using credit wisely or unwisely, get credit at prevailing market interest rate, with scheduled payment plan from regular sources like banks, or other financial institutions. Their less educated, low income counterparts, on the other hand, would be more prone to turning to private lenders like Payday Loans, and Money Marts. The latter are likely to have either no clue about the aftermath of what they are doing by borrowing money from such lenders, or their need is so strong that they give a damn to what happens to them the next day, next week, next month. What they want is immediate access to cash money even if it leads them to a deep and suffocating hole.

Theoretically speaking, the financial literacy program should be good for low-to-mid income people who can’t handle or manage their money better. This program will indeed teach them a variety of skills to manage their money. However, what they really need first is a stable and a right frame of mind to concentrate on the learning process. And this they would have it only when they have good enough access to cash to meet their needs.

Once they have enough money, then only they can be taught some budgeting techniques, ways to save, ways to control spending, ways to use debt wisely, etc. In addition to helping Canadians to improve their financial capability, both the federal and provincial governments should introduce measures aimed at moderating the demand for credit – like moderating the rising prices of homes, volatility in both the real estate and financial markets, and consumers’ habits of spending borrowed money. For example, if we can bring down the purchase price of a home, we can also bring down the amount of mortgage debt required and its associated monthly payment – all resulting in a more cash, or lesser use of credit, for an owner. The sad part is that no government would like to introduce such measures controlling credit as all of these, in one form or another, essentially help the growth of the nation’s economy. And, who wants to stop that?

Empirical evidence that the financial literacy program is not working

Since 2009, the year the program was introduced by the federal government, Canadians overall owe more today than they did eight years ago. For instance, for each dollar of disposable income they made, they owed $1.67 in 2016 compared with $1.55 in 2009. Between these years, the overall household debt has risen from $1.4 trillion to $2.0 trillion – an increase of $600 billion. And, 80% of this increase is attributed to the increase in residential mortgages, and the other 20% to consumer debt. The rate of growth of total debt (42.8%) has outpaced the rate of growth in personal disposable income (32.3%). Put simply, Canadians are spending money they haven’t yet earned. It’s long-term effects are not good either for the economy, or for the future generation.

Using debt wisely – a skill or a behavioural issue?
Of the two debt components – residential mortgage and consumer debt – the indebtedness in respect to the former is by choice, and it’s considered as a good choice as long as it is made keeping viable affordability in mind, whereas that in respect to consumer debt is largely behavioural (with the exception of those with no savings or any cash flow, and who simply breathe on borrowed money).

Mortgage debt is considered as a good debt as it’s taken to purchase a home – one’s key asset over a lifetime – that also appreciates over time. As one pays off the mortgage debt over time, one builds equity in addition to the appreciation in the value of home due to the changes in the local and national real estate markets. This rising equity in home provides the owner some sense of future financial security. Any undertaking of mortgage debt requires some set of skills right from the choice of a lender to the negotiations about the amount sought, its amortization, interest rate, frequency of payments, lump sum payment without a penalty, etc. For example, an average person may opt for a monthly payment schedule whereas a more skilled may opt for a weekly payment, saving oneself thousands of dollars of interest by repaying borrowed money over a relatively shorter period.

Consumer debt, on the other hand, is largely considered as a bad debt as individuals use it for varying reasons – ranging from grocery shopping to taking holidays, paying off monthly bills, on-line shopping, taking cash advances – you name it. Since consumer credit is “cash available 24/7”, one uses it for day-to-day shopping of both essentials and non-essentials to satisfy one’s current needs or consumption, or maintain one’s lifestyle. The use of this credit also reflects one’s spending habits, or behaviour as a “sensible or conservative spender”, or a “compulsive or frivolous spender”.

Spending is a ‘behaviour’, and not a ‘skill’ to be learnt from any financial literacy program. For example, does one need any skill to order a product or book a vacation package on-line and pay by credit card? No. One wants something on the spot, orders it right away (impulsively or non-impulsively), and pays by readily available credit card, line of credit, or any other form of revolving credit. No second thought on the purchase, or any analytic aftermath.

The only way to control spending behaviour and its related borrowing is to learn to exercise some degree of self-control or budgetary restraints – which only a person him/herself can devise and implement. No classroom program is going to enforce it. How to exercise such restraints is a completely different topic, and beyond the scope of this short post.

Because of the prolific use of credit cards and easy access to lines of credit coupled with low interest rates, Canadians have increased their consumer debt load by 26% (or $118 billion) between 2009 and 2016. This translates to $46 million a day over seven years. That’s a hefty dose of daily consumer indebtedness that may even be hurting a particular segment of Canadians.